“Green” investments currently have many investors either seeing red or feeling blue. The MAC Global Solar Energy Index (SUNIDX) has plunged more than 94% since its April 2008 inception. The more diverse WilderHill New Energy Global Innovation Index (NEX), which tracks 98 clean energy stocks, fell nearly 74% over the five years ended November 20, 2012.
But some investors aren’t letting this volatility or the slow transition to a low-carbon economy dampen their enthusiasm. Instead, they’re casting a wider net around the global environmental markets universe and fishing for attractive long-term growth opportunities.
After all, the environmental issues aren’t going to go away—nor are the opportunities. Impax Asset Management, a London-based specialist in global environmental markets and subadvisor to the Pax World Global Environmental Markets Fund (PGRNX), expects resource scarcity and the need for greater energy efficiency to be major drivers of global economic growth for the foreseeable future for a number of reasons.
First, the world’s population is projected to exceed 9 billion people by 2050, one-third higher than in 2009. Approximately 70% are expected to live in urban areas, up from 49% in 2009. To feed everyone, global food production must rise 70%—which will require significant water and energy. (The figures come from the Food and Agriculture Organization of the United Nations.)
Additionally, half the world’s population is expected to be living in areas of high water stress by 2030 (a U.S. Environmental Protection Agency prediction). The U.S. will require $180 billion in water infrastructure investment each year to 2030 (a World Bank estimate). The Chinese government has earmarked $780 billion of investments in water assets by 2020 to cope with the country’s increasing urbanization.
The rising affluence in emerging markets, the weather extremes and the high cost of replacing natural materials will also place demands on the world’s finite natural resources, says Bruce Jenkyn-Jones, co-manager of the Pax World fund since its 2008 inception and the managing director of the listed equities team for Impax. “While the Obama win brings into focus the concerns about the impending fiscal cliff,” says Jenkyn-Jones, “the relative implications for environmental markets now look more positive than those for other sectors.”
Impax calculates that the environmental markets make up 6% of the global stock market and include some 1,400 companies with $500 billion in combined annual revenues. Its data suggests that these markets could see sustained compound annual growth rates of 10% to 20%. Still, valuations remain very much in line with the broader global markets, says Jenkyn-Jones.
Impax looks for policies and legislation that can be catalysts for growth, he says. It expects China’s current five-year plan to trigger an acceleration of investments in environmental markets. Europe’s energy efficiency directives are already helping across the board, he says. Meanwhile, states are setting standards in the absence of federal legislation. In November, California launched the nation’s first cap-and-trade program for greenhouse gas emissions.
Jenkyn-Jones also expects to see many more mergers and acquisitions in the environmental markets since larger companies wanting exposure to these rapidly growing sectors often prefer to acquire an established business rather than assume the risk associated with building one. Nearly three dozen M&A transactions have occurred in this arena over the past decade or so.
The shift to new opportunities, however, has required a bit of rebranding. Pax World Management LLC, based in Portsmouth, N.H., rechristened the Global Environmental Markets Fund (PGRNX) in August, changing its name from the “Global Green Fund” to make it clear that the vehicle has a broad environmental mandate and isn’t just about alternative energy. At least 40% of the fund’s net assets are required to be in the securities of non-U.S. issuers.
“There’s no change in strategy,” says Jenkyn-Jones. Instead, he says, the name change “reflects that we’re trying to communicate diversification.”
Just 2.6% of the fund’s holdings were in renewable and alternative energy at the end of the third quarter of 2012. That compares with 33.6% in energy efficiency, 23.6% in water infrastructure and technologies, 18.2% in pollution control and 10.6% in waste management and technologies.
A top holding in the Pax World fund is German engineering firm GEA Group AG, a leading maker of heat exchangers used in industrial applications. Jenkyn-Jones, who describes GEA as an energy efficiency play, likes the markets it’s in, has confidence in the company’s new management team and thinks it can increase its return on capital. “It’s a potential turnaround story,” he says. The company’s American depositary receipts (ADRs) trade over the counter in the U.S. under the symbol “GEAGY.”
Another holding is Legrand SA, a France-based global specialist in electrical and digital building infrastructures that provides solutions for efficiently managing lighting, heating and ventilation. Its lighting management systems and presence detectors can help users trim their power bills by as much as 55%, according to the company Web site. Its products include dimmers, sensors that detect movement and green sockets that cut power to certain office equipment at night and during weekends. The company’s stock trades over the counter in the U.S. under the symbol “LGRVF.”
Pax World’s Asian holdings include China Everbright International Ltd. and ENN Energy Holdings Ltd. The first company focuses on converting waste to energy and has been able to secure attractive contracts, says Jenkyn-Jones. ENN is a natural gas distributor in big Chinese cities, which have historically burned a lot of coal. “Beijing has been a wake-up call for the need to move away from coal,” he says. China Everbright’s stock (CEVIF) and ADR (CEVIY) both trade over the counter in the United States, as do ENN’s stock (XNGSF) and ADR (XNGSY).
Illiquidity is a major shortcoming of U.S.-listed foreign securities, including these Pax World holdings, so buying shares in a mutual fund can be a more attractive way for investors to gain exposure to many of them, Jenkyn-Jones says.
Pax World’s fund also holds U.S.-based Xylem (NYSE: XYL), a leading global provider of water technology that was spun off last year from ITT Corp. Xylem, whose products include pumps and wastewater membrane treatment systems, has good return on equity and an ambitious management team, says Jenkyn-Jones. The fund increased its position in Xylem after a fall in the company’s share price, a result of investors’ concern about Xylem’s European Union exposure.
By and large, Jenkyn-Jones thinks the risks associated with the weak EU economy are already priced into many stocks in the environmental markets. Companies in general are moving toward automating operational efficiencies despite this economic weakness, he says.
The renewable energy sector is also sporting some attractive valuations, but Jenkyn-Jones says he’s currently hesitant. “We’re watching it closely, but we’re not ready.” What must happen first, he says, is more industry consolidation and M&A activity and a rise in gas prices. “I think the renewable energy sector is on the cusp of a consolidation period,” he says.
The Perfect Storm
Bethesda, Md.-based Calvert Investments also remains enthusiastic about the global environmental markets. “The perfect storm of trends is creating real opportunities for clean technology and water,” says Jules Frieder, a senior sustainability analyst with the firm.
Not only is the global population surging, “the water isn’t where the people are,” she says. China, for example, has approximately 20% of the world’s population but just 7% of its potable water.
Other key macroeconomic developments should also offer tremendous opportunities in the water space, says Frieder. Water will be affected by regulations at the local, state, federal and international levels; by technology developments; and by biodiversity concerns. She points out that farmers in West Texas are now restricted from pumping groundwater.
Worldwide, she expects significant investments related to building and improving water delivery and storage.
Among the holdings in the Calvert Global Water Fund (CFWAX), Frieder finds Xylem particularly attractive, largely because of its pumping technology. She also likes Canada-based Pure Technologies Ltd., which builds products for critical infrastructure maintenance, such as devices that detect leaks in water and wastewater pipelines. The fund holds Canadian shares, since they offer greater liquidity than those trading over the counter in the U.S. (where the company’s symbol is PPEHF).
Ellen Kennedy, a senior sustainability analyst and manager of environment, water and climate research at Calvert, expects the global environmental markets to get another boost from rapidly growing emerging economies. These up-and-coming foreign markets are expected to account for nearly 60% of global gross domestic product by 2030, according to the Organisation for Economic Co-Operation and Development (OECD). She expects many more opportunities in the U.S. as well.
Kennedy sees big appeal in Danaher Corp. (NYSE: DHR), a U.S.-based scientific and technology company also held by the Calvert Global Water Fund. Two of its subsidiaries are developing ultraviolet technology to treat ballast water, taken in by oceangoing ships so they can maintain their stability in transit. In the past, ships dumped this organism-infested water offshore, wreaking havoc on ecosystems. In early 2012, the U.S. Coast Guard issued a federal rule requiring ships entering American waters to install onboard systems to filter and disinfect the ballast water. International regulations are also pending, notes Kennedy.
Another factor that she says could provide opportunities in the water sector is the U.S. EPA’s current efforts to strengthen limits on micro-contaminants in drinking water. “The Obama victory is also a win for more favorable climate change and renewable energy policies, and for the clean tech industry,” says Kennedy. “We are optimistic that on a bipartisan basis, renewable energy and energy efficiency will benefit from tax incentives, especially the extension of the wind production tax credit in 2013.”
In October, two dozen investors with more than $800 billion of assets under management, Calvert included, asked congressional leaders to extend this production tax credit for renewable power. The provision, originally enacted as part of the Energy Policy Act of 1992 in order to stimulate investment in renewable energy, has been a major driver of wind power development in recent years.
The climate change debate is also now back on the agenda, in part because of the terrible effects of Hurricane Sandy, says Kennedy.
One of Kennedy’s favorite holdings in the Calvert Global Alternative Energy Fund (CGAEX) is U.S.-based Johnson Controls (NYSE: JCI), a developer of energy-efficient technologies used in the automotive and building industries. She describes another CGAEX holding, Denmark-based Novozymes A/S, as "an interesting green chemistry innovation story." The biotech company's enzymes help multiple industries boost product and material efficiency. For example, it has partnered with Procter & Gamble to develop laundry detergents that are effective in cold water washes. Cold water dramatically decreases energy usage, she says. Calvert purchases the company’s B shares from the Copenhagen Stock Exchange. Its ADR also trades over the counter in the U.S. under the symbol “NVZMY.”
Pax World doesn't invest in companies that directly engage in the controversial practice of fracking, which extracts natural gas from rock, but it does have exposure to some companies that assist in fracking efficiency or cleanup efforts, including Xylem. Calvert doesn't exclude companies that engage in fracking but it seeks out those that employ best practices and advocates with them for better disclosure. Another holding in the Calvert Global Water Fund, Gardner Denver (NYSE: GDI), makes blowers and pumps that allow for less water usage in fracking operations, says Kennedy.
Financial advisors interested in the global environmental markets should seek a wide breadth of exposure to help reduce risk, says Jenkyn-Jones. He also suggests being patient. While global environmental markets portfolios can act like any diversified equity portfolios in the near term, the fundamentals supporting their growth, such as resource scarcity, will kick in down the road. “We’d try to sell this as a long-term strategy,” he says.